MaxLinear’s Bid for Silicon Motion: Making Meaning of the Deal
Silicon movement (NASDAQ: SIMO) develops integrated electronic circuits and microcontrollers, which are mainly used in the production of NAND flash memory for storage devices. Then, its potential takeover by MaxLinear (NASDAQ:MXL) come all the more surprising given that the latter’s product range mainly covers radio frequency (“RF”) communications, 5G wireless infrastructure, optics for broadband connectivity and connected home applications.
So SIMO’s technology may not fall within MaxLinear’s core focus areas could be the reason investors dumped MaxLinear shares on May 5th, as seen in the blue chart below, shares of the company dropping by about 30%.
Conversely, as an acquisition target, investors rewarded SIMO with an upside of around 20%.
The objective of this thesis is to make sense of the agreement while keeping in mind that in the current economic context and the challenges of the supply chain, it is important to focus on other factors than the only technology. I begin by explaining why SIMO, which was already looking for a potential takeover in April, is an attractive acquisition target.
The attractiveness of SIMO in acquisition
SIMO is a fabless company that designs semiconductors. Founded in 1995 in California before having its headquarters in Taiwan, it has design centers in the United States, Taiwan, South Korea, China and Japan. It has grown at a phenomenal rate of 71% in 2021, on an annual basis, due to the increased demand for custom chips that need to be designed before being produced, as opposed to standardized chips that are readily available commercially. shelf.
The company’s innovative approach lies in the way it develops NAND flash controllers, including using MMC (Multimedia Card Controller) technology.
These in turn are used to manufacture storage SSDs (solid-state devices) by hardware manufacturers such as ScanDisk, Toshiba, Samsung Electronics (OTC:SSNLF) and others. These SSDs are capable of storing more data per disk than other NAND technologies. This ultimately means higher storage density and lower costs for big data-hungry technologies. SIMO also supports the latest generation of TLC (Triple-level Cell) flash and has gained a leading position in MMC controllers used in smartphones and tablets.
As for MaxLinear, its analog and mixed-signal ICs are used in 5G wired and wireless infrastructure and data center optical interconnects that require high-speed connectivity. One of its key innovations is the low-power tuner chip used in TVs and set-top boxes as part of IPTV offerings around the world.
Its customers include Intel (NASDAQ:INTC), Teradyne (TER), Dell (DELL), Cisco (CSCO), etc. It is also a leading supplier of analog and mixed-signal integrated circuits for connected home and industrial applications. The company is based in California.
Therefore, although there is some similarity, especially in terms of RF technology, these two companies mainly offer different types of products and their customers also differ.
Nevertheless, there are synergies.
Revenue and cost synergies
The primary goal of the acquisition appears to be for the merged entity to become more of an end-to-end chip provider, from storage and networking to data centers, not to mention mobile wireless. It will also advance MaxLinear’s strategy to increase scale and diversify sales to more end customers, especially those with Tier 1 platforms.
Tellingly, the combined entity will have access to a total addressable market of $15 billion, roughly double what MaxLinear can achieve on its own. At the same time, as I mentioned earlier, it will double in scale with a market capitalization of over $6 billion. Total revenue will also double to nearly $2 billion, achieved by adding the individual numbers in the table below, while having access to an additional talent pool of over 1,400 specialist employees, which is a plus. in this tight labor market.
Additionally, the acquisition has the potential to create a major fabless semiconductor supplier. Now, since the two companies have to rely on contract manufacturers such as Taiwan Semiconductor (TSM) for the supply of chips to use as components for their advanced electronic circuit boards, a combined entity could place high-volume orders. , which means more economies of scale, which would in turn translate into lower production costs. This can lower the cost of revenue, which means better gross margins.
With different customer bases also comes the ability to identify cross-selling opportunities without necessarily having to spend more on marketing, with one of the areas likely to be automotive. In this regard, SIMO has developed a range of storage solutions for EVs (electric vehicles) and autonomous driving applications. Today, with the densification of electronic content in cars where more chips are used in their control systems, just like servers in a data center, storage technologies using NAND flash memory can promote performance and optimum reliability. Additionally, automakers are aiming for a sophisticated in-car infotainment and navigation system.
For investors, the increased penetration of semi-trailers in the automotive industry represents a market in its own right, which is expected to grow by 38.1% CAGR from 2022 to 2030.
Ratings and Key Takeaways
So there’s the narrative of synergistic growth, but, getting back to inflationary pressures and supply chain bottlenecks, I’m putting more emphasis on profitability.
First, more scale means more revenue can be spread over the same fixed costs, which translates into better gross margins. Continuing further, as the cost of doing business increases, the higher EBIT (or operating) margins of SIMO compared to MaxLinear, as shown in the table above, are worth highlighting. These were achieved despite the Taiwan-based company starting out with 51% lower gross margins than its US counterpart. This, in turn, means that SIMO incurs less operating expenses, likely due to maintaining much of its staff in Taiwan, Japan, China and South Korea, where the impact of inflation wages is lower than in the United States.
Second, with its successful M&A track record, MaxLinear is expected to integrate SIMO to leverage technology expertise, thereby benefiting from cost synergies. To that end, the deal is expected to be immediately accretive to net income, including operating income and EPS. On the cash flow side, SIMO’s $174 million has the potential to increase MaxLinear’s $168 million operating cash flow by more than 100%, based on 2021 numbers.
Digging deeper into the bottom line, to get the combined GAAP EPS for the year ending December 2022, I added SIMO’s projected earnings of $7.46 to $9.34 to the 3.84 $ to $4.18 from MaxLinear using midpoints. I get $12.41 (8.4 + 4.01) and dividing the MaxLinear stock price of $39 by that number gives me a P/E of 3.14x. This is well below the current GAAP P/E of 19.12x (table below).
This means that in the event that the transaction closes in the current calendar year, MaxLinear could be undervalued by approximately 85% ((3.14-21.83)/21.83)) if considering the sector’s median P/E of 21.83x. Now, increasing MaxLinear’s current stock price by $39 by 85% gives me a target of $72, which is still below Wall Street’s forecast.
However, the deal could take some time to materialize given the number of jurisdictions it has to traverse to gain regulatory approval, particularly in China where SIMO is a leading supplier of SSD controllers for flash. TLC. It is a technology considered crucial to replace mechanical hard drives in favor of TLC SSD which offers relatively higher performance and a competitive advantage over traditional storage.
Therefore, there are certain regulatory risks if the geopolitical environment between the United States and China worsens over Taiwan. These risks may explain why, at $91, SIMO shares fall short of the $114.34 offered as part of the $93.54 cash plus 0.388 common share of MaxLinear. The offer price now represents a 48% premium to SIMO’s stock close on April 22, 2022, and despite rising 20%, the company remains undervalued in terms of p/e multiples per compared to the industry median of at least 23%. So, based on valuations, SIMO is a buy and can still yield $10-11 on a positive regulatory move.
As for MaxLinear, it only had $170 million in cash and cash equivalents last quarter and therefore will need to fund the $3.1 billion cash portion of the acquisition with debt financing. To that end, the company had $325 million in debt on its balance sheet at the end of March and a low long-term debt-to-total capital ratio of 37%. Based on the valuation metric alone, the company is a buy, but the adverse market reaction to the company’s stock when the deal was announced shows risk aversion, possibly due to the a relatively large amount of money that the company will need to borrow from banks, especially in times of rising interest rates. So, despite its lower valuations, I view the company as a hold because it executes the trade.
Finally, this acquisition comes with revenue and cost synergies, but there are risks of regulatory delays that can cause both stocks to be volatile. That said, SIMO is a buy, but wait for the market to stabilize before investing.